Tuesday, 9 May 2017

Multilateral Development Banks: Policy Options for the Next German Government

This post first was published early May in German on request of Stephan Klingebiel for the German Development Institute: 

2015 was the year of important summit promises made by the UN and heads of states that yielded some of the most ambitious global commitments ever made:
1.       The 3rd Conference on Financing for Development in Addis Ababa;
2.       The Summit in New York on Sustainable Development Goals (SDGs); and
3.       The 21st Climate Change Conference in Paris.
2016 followed to witness the delivery promise by ten multilateral development banks (MDBs) and the IMF:  We stand ready to support the realization of these ambitious UN summit promises into reality[1]. Table 1 presents those MDBs that committed to the delivery promise through their presidents´ signatures. The Table will help the next German government to monitor these institutions for the implementation of their promise and to take them to task. Talk is cheap, especially at UN summits, but implementation is critical to improving lives and protecting the planet.

Table 1: Multilateral Development Banks with SDG Delivery Commitments
Multilateral Development Banks
African Development Bank
Asian Development Bank
Asian Infrastructure Investment Bank
European Bank for Reconstruction and Develoment
Europen Investment Bank
Inter-American Development Bank
International Finance Corporation
Islamic Development Bank
New Development Bank (BRICS)
World Bank

The MDB bosses declared that the can translate the SDGs into meaningful country-level targets, policies, programs, and projects needed to achieve them. They would provide not only the necessary financing—either directly or by helping to “unlock” and catalyze additional public and private resources—but also policy advice and technical assistance supporting countries to build domestic capacity and to identify needed priority investments with the right standards.  At the same time, the IMF and the World Bank would strengthen their debt sustainability assessment tools to ensure that investment scaling-up in the wake of the summit promises  do not threaten the sustainability of public finances. So much for self-promotion.
With respect to the summit and delivery promises and the MDBs, three central strategic questions will confront the next German government:
·         Which share of the aid budget is to be spent via multilateral rather than bilateral channels?
·         How to allocate German budget contributions across the MDBs?
·         Which priority will be given to poverty reduction in the poorest countries relative to financing global public goods?

Aid allocation: Bilateral or multilateral delivery channels?
Budget allocation between bilateral and multilateral delivery channels can be guided by two important criteria: 1) Who has the comparative advantage to deliver on specific SDGs effectively and efficiently? 2) Which channel helps better promote the priorities of partner country and donor country?
Usually, multilateral are preferred over bilateral agencies for some genuine advantages: Know How (to fight poverty and pandemics), basic research (for example on agricultural seeds), to combat global climate change, global terror, financial crises and shortages of water, food and energy. These are classic global public goods that constitute the case for the necessity of multilateral organizations also for aid delivery.
Where – unlike in Germany – national agencies of aid delivery are hardly present, a hard decision is often avoided via cherry picking multilateral organizations for earmarked (´bilateral`) purposes. By contrast, German contributions to multilateral institutions are mostly contributions to their core budget. The high share of core budget payments in German contributions to multilateral organizations is welcome and should not be reduced. Many international organizations, especially at the UN, suffer from eroded core budgets that leads either to their effective ´privatization´ (example: the World Health Organization budget financed by the Gates Foundation) or to mission creep, mandate encroachment and fund shopping by management. This leads to aid fragmentation, costly for poor countries with thin administrative capacities.
To be sure, the risk of aid fragmentation is much higher when aid is delivered via bilateral channels, given the multitude and competition of bilateral aid agencies and of private donors. However, the bilateral channel is tempting for an export oriented country such as Germany as it will serve as a door opener for good bilateral relations, which imply stronger trade relations.

Assigning Mandates across the MDB Space
In the past, the bulk of multilateral lending has been provided by institutions created and ruled by the west. The pressure for the BRICS to ‘exit’ had risen with past, present and expected failure for ‘voice’ reform in the established international financial institutions (IFIs). With the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB), two multilateral banks created in 2014 outside the established Bretton Woods system, choice has increased for borrowers and capital donors alike as the new institutions led by China and the other BRICS help rebalance multilateral development finance away from western dominance[2]
To avoid the administrative burden on developing partners that may arise through fragmented MDB lending, it remains important to avoid mandate duplication and overlap, to reduce mission creep and to arrest multilateral fragmentation[3]. The fragmentation of multilateral development cooperation is not just a problem for developing countries, but equally for sponsors in donor countries. They have so far often fulfilled the task to direct and control the management of multilateral development banks by benign neglect.
A clear role assignment and coordination of the multilaterals will help reduce mandate shopping and hopefully raise their efficiency and effectiveness. This requires first and foremost to find out comparative advantage across the MDB space in supporting specific SDG goals (of which there are 17 with 169 targets between them). Because of ministerial patronage and conflict of interest the mapping of comparative advantage cannot be trusted upon specific ministries, let alone upon international organizations (nor upon academics that depend on them). The most promising procedure is to have the heads of states to entrust national audit agencies with mapping comparative advantages in the MDB space[4].

Which Role should MDBs have for the Bottom Billion?
The Communiqué released by G20 Finance Ministers and Central Bank Governors at their meeting in Baden-Baden over March 17-18, contained the following, less noted, declaration:
“Given scarce public resources and the key role of the private sector for sustainable economic development, we welcome the work by Multilateral Development Banks (MDBs) on mobilising private capital. We call on MDBs to finalise Joint Principles by our next meeting and develop Ambitions on Crowding-in Private Finance by the Leaders Summit in July 2017. We look forward to the joint MDBs’ reports on the implementation of the MDBs Balance Sheet Optimisation Action Plan…”
Following a decision made in 2015, The AsDB has become a pioneer of merging concessional and non-concessional balance sheets in order to raise leverage on MDB capital. Since the AsDB merger, the assets of the concessional loan window, named the Asian Development Fund (AsDF), have been treated as equity and brought onto the bank’s core balance sheet. The inclusion of AsDF equity, comprised of $30.8 billion in loans outstanding and $7.2 billion in liquidity/receivables, effectively tripled AsDB capital to $53 billion. The Washington-based Centre for Global Development (2016) estimates that the move increased the AsDB lending capacity by 50%. The new regulations for the AsDF were released by the AsDB on 1st January 2017.
Reforms are also ongoing in other international financial Institutions. The IDA, following its 18th Replenishment, plans to leverage its capital for non-concessional loans through a private-sector set-aside window. The African Development Bank (AfDB) is opening its non-concessional window to the poorest countries. Also IFAD – an MDB and a specialized UN agency – is exploring options for changing the financial architecture, so as to increase the size of the programme of loans and grants.
The AsDB merger has been described as “win-win-win”: AsDF countries see expanded access to lending; AsDB countries also see expanded access (on non-concessional terms); and AsDF donors see a 50 percent reduction in their contributions to the grant fund as a result of a smaller pool of eligible countries. Is this too good to be true – a free lunch?
We need to consult MDB balance sheets to see when the MDB windows merger will bring the advertised results:
  • On the liability side, the ratio of concessional to non-concessional equity determines lending potential of merged windows. The more concessional equity can be merged into non-concessional equity, the more bang for the buck can be expected.
  • On the asset side, composition of borrowers—those requiring concessional lending terms and their size relative to non-concessional borrowers – will define the leverage ratio as non-concessional lending raises the leverage ratio while concessional lending will reduce it toward 1.
Table 2: MDB Balance Sheet Ratios
Equity ratio 
Leverage ratio
Sources: Moody´s; CDG (2016); MDB annual reports; own calculations.

The net result of window mergers on MDB lending capacity will depend on how much additional finance the balance-sheet reform produces, and how much of the additional resources is absorbed by a higher concentration of fragile and conflict affected countries in the remaining pool of IDA countries. The World Bank balance sheet lends itself to the optimization proposed by the G20: Both the equity ratio and the leverage are comparatively high, so that lending capacity can be increased significantly by the window merger. In contrast, the room for manoeuvre is quite limited for the AfDB. This kind of redirection of investment priorities away from social investments toward hard infrastructure investments could be fatal in Africa where fragile and conflict affected countries are plentiful, and where the majority of countries are still dependant on concessional lending[5]

[1] http://www.worldbank.org/en/news/press-release/2016/10/09/delivering-on-the-2030-agenda-statement
[2] Helmut Reisen (2015), “Will the AIIB and the NDB Help Reform Multilateral Development Banking?”, Global Policy, Vol. 6,  Issue 3, September, pp. 297–304.
[4] To entrust the national audit authority on evaluating engagement with multilaterals was pioneered in the UK. See National Audit Office (2005), Department for International Development: Engaging with Multilaterals, London: NAO.
[5] See more detail in Helmut Reisen (2017), On the G20 call for MDB Balance-Sheet ´Optimization´, T20 Germany Blog, German Development Institute, 11 April.